A few days ago, I made the passing observation that if Fed officials are inclined to believe the latest leg higher for long-end US Treasury yields can stand in for the final rate hike tipped by the dot plot, they shouldn’t be too explicit about it.

The risk is as clear as it is familiar: The market is forward-looking, so if the Fed suggests they’re likely to skip another rate hike in light of the tightening impulse from the sharp term premium repricing and higher real rates, yields could retrace lower, the dollar could fade and stocks could rally. That, in turn, would negate the very rationale for skipping the final hike.

On Friday, Nomura’s Charlie McElligott called that a “dysfunctional feedback loop” or “extreme FCI reflexivity.” “The Fed says ‘the market did the (tightening) job’ for them over multiple weeks, but then the market undoes that job in the matter of just a few days,” he wrote.

That’s problematic as long as the data continues to suggest the economy is resilient: FCI easing into economic strength and stubborn inflation is gas on the fire, which in turn prompts markets to think still another step ahead, adding rate hike premium back into this year’s remaining meetings and/or taking down cut pricing for 2024.

Here again we see why less should be, but never is, more, when it comes to Fed communications. Talking for the sake of it isn’t always helpful and can often work at cross-purposes with monetary policy’s goals. Fed officials seem to think there’s no such thing as too much communication — as if institutional transparency demands somebody (and usually several somebodies) has to give a speech or make a TV cameo every weekday.

In any case, this dynamic isn’t quite as tedious now as it was when the Fed was still miles below terminal and inflation was still raging. Maybe policy is “sufficiently restrictive,” maybe it isn’t, but it’s more restrictive than it was, and with rates above 5%, the Fed’s arguably risking financial instability given how rapidly the tightening cycle played out from the lowest of low bases.

That suspicion (that “another March,” if you like, looms) could put a lid on yields, particularly as the Fed’s messaging around “how long” is for now unwavering, even as risks pile up. Thursday’s long bond selloff was a function of a poor auction result, and the fact that yields were right back lower again Friday on geopolitical concerns suggested “the recent bullish mood-shift” might have some staying power, according to McElligott.

“Buyers of duration continue to show resolve and confidence that the recent impulse tightening in financial conditions and purported Fed ‘higher-for-longer’ commitment increases the probability of a deeper economic slowdown in the future,” he said. “Especially with [the] disinflationary trend intact, despite the noise of the September CPI / PPI prints.”

Bonds are still properly described as a falling knife. Investors plowed a record $18 billion into the world’s largest Treasury ETF in 2023, a wrong-way bet amid $10 billion in estimated losses, according to Bloomberg.

The drawdown for TLT reached 50% this month.

Earlier Friday, I reiterated that bonds now exhibit a highly asymmetric return profile. Another bullish asymmetry can be found in positioning. Charlie flagged the potential for “further synthetic short gamma accelerant flows via CTA unwinds” in short rates expressions which drove most of the trend-follower PNL over the past two years.

The figure below shows performance attribution across the CTA trend space going back to October of 2021.

“The aggregate PNL between ‘short bonds’ and ‘short STIRS’ positions contributed +15.34% of the overall +23.29% return in the Nomura QIS CTA model portfolio, or two-thirds of the aggregate return for the multi-asset trend strategy,” McElligott noted, adding that the prospect of monetization and profit-taking adds to the “‘buyers are higher’ concern in USTs and STIRS, with flows asymmetrically tilted to buying.”

Importantly, those kinds of flows (e.g., profit-taking and winner monetization) will be incentivized if bonds look reluctant to sell off any further beyond the “worst” (i.e., cheapest) levels seen over the past several weeks.